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The arithmetic of giving to charity

Summary

The proposal to limit tax relief for charitable giving has caused great controversy.

Much of the debate has misrepresented the issue.

I explain the issues with some simple numbers.

17 April 2012

Much of the UK political discussion since the Budget on 21 March 2012 has focused on the tax relief for giving to charity. Unfortunately most of the discussion has ignored the facts regarding how the tax system works.

Accordingly I have written this page to explain how the relief works and its implications.

Assumed circumstances

Fred starts the year owning quoted shares worth £1 million. During the year he earns a salary of £1million.

Fred wants to give £1 million to his favourite charity.

For simplicity the calculations below ignore personal allowances and the basic rate tax band. They use the proposed 45% new top rate of tax.

Calculations

There are a number of different scenarios to consider. They show how the £2 million (Fred’s quoted shares and his salary) ends up being divided between Fred, the Treasury and the charity.

If Fred gave nothing to charity

Fred would pay tax of £450,000, calculated as £1,000,000 @ 45%.

Fred would end the year with £1m in quoted shares and £550,000 in cash from his salary after paying tax.

The Treasury collects £450,000.

The charity receives nothing.

If Fred gives his salary away

Due to the way the gift aid scheme works, Fred needs to give £800,000 in cash to the charity. That reduces the tax rate on his salary from 45% to 20%, so Fred pays £200,000 in tax.

The charity receives £800,000 from Fred and a £200,000 gift aid tax refund from the Treasury.

The Treasury collects tax of £200,000 from Fred but refunds the same amount to the charity.

Fred ends the year with the £1m in quoted shares he started with, and has no cash.

The Treasury has collected no tax overall.

The charity has £1m.

If Fred gives his shares away

As an alternative, Fred could give the charity his £1m worth of quoted shares. That gives him a £1m deduction against his income, so he pays no tax on his salary.

Fred ends the year with £1m of cash from his salary, but has no shares.

The Treasury has collected no tax.

The charity has £1m of quoted shares. It can sell these in the stock market if it wants cash to spend on charitable activities.

Charitable giving relief restricted to 25% of income

Paragraph 1.192 of the Budget Document reproduced below gives all the details we have of how the relief will be restricted.

1.192 To curtail this excessive use of reliefs the Government will introduce a limit on all uncapped income tax reliefs. For anyone seeking to claim more than £50,000 of reliefs, a cap will be set at 25 per cent of income. This will increase effective tax rates and help ensure that those with the highest incomes pay a fairer share. This will not be extended to those reliefs that are already capped, as to do so would reduce the amount of support the tax system gives, for example, to enterprise and pension contributions.

Assuming that this stops Fred claiming gift aid relief in excess of his income, the most he should give to charity is £200,000. His tax liability would then be calculated as follows:

Income

Tax

Taxable at 20%

250,000

50,000

Taxable at 45%

750,000

337,500

Total

1,000,000

387,500

Fred would pay tax of £387,500 in total.

The Treasury would collect £387,500 from Fred but refund £50,000 tax to the charity under the gift aid scheme, keeping tax of £337,500.

The charity would receive £200,000 from Fred and £50,000 as a tax refund from the Treasury.

Accordingly, the total £2m would be divided up as follows:

Fred finishes the year with £1m in quoted shares and cash of £412,500.

The Treasury has collected tax of £337,500 net of the refund given.

The charity ends up with £250,000.

Fred gives the rest of his cash to the charity

Much of the recent political discussion has pointed out that Fred can still give to charity even if he does not get tax relief.

Making the assumption that any further giving by Fred would not receive any gift aid relief, the most that Fred can give is his remaining cash of £412,500. If he does that, the finishing position is:

Fred finishes the year with £1m in quoted shares and no cash. Accordingly he has been as generous as in the first example.

The Treasury has collected tax of £337,500 net of the refund given.

The charity ends up with £662,500.

The charity ends up with less money than in the very first example, because the Treasury has collected £337,500 of tax.

Policy discussion

Much of the political debate has been around rich people reducing their taxes by giving to charity. That is a diversion from the real issue.

The real issue is that if the Treasury is to collect more tax, that tax has to come from somewhere, and as the example shows it comes from reducing the amount of money that the charity ends up with.

It is a question of one’s political philosophy whether you regard the charity sector or the government as the more worthy cause to receive one’s money. Most people would rather give to the charity of their choice than have their money go to the government, if they had a choice.

Bogus charities

These have occasionally been mentioned. However they are also a diversion from the real issue. There are plenty of existing rules under tax law and charity law that allow bogus UK charities to be shut down, and tax relief denied to donors.

Charitable giving tax relief also has to be granted for donations to charities established elsewhere in the European Union due to the UK’s obligations under the EU treaties. However if foreign charities are suspected of operating improperly, the UK can deny tax relief.

Where do I stand?

I suspect this idea of restricting tax relief for large charitable donations originated with the Liberal Democrat party. I regard the idea as fundamentally flawed, as it will lead to many large charitable donations not happening.

When one looks at the numbers, the only way that the Government can raise tax revenue by this change is by depriving the charity sector of money. It is incorrect to think of this as a way of taxing “rich people.” It is a measure that effectively taxes charities.

The Government has indicated that it will be consulting on the proposed measure. I hope that leads to the idea being dropped. Britain needs more philanthropy, not less.

Update 2 June 2012

On 31 May 2012 the Financial Times newspaper reported that the Chancellor of the Exchequer had given a television interview to announce that the limitation proposal had been dropped. (Obviously the consultation mentioned above will not now take place.) He was quoted by the Financial Times as follows:

Mr Osborne said in a short television clip: “I can confirm that we will proceed next year with a cap on income tax reliefs for wealthy people, but we won’t be capping relief for giving money to charity.”

He added: “It is clear from our conversations with charities that any kind of cap could damage donations and, as I said at the Budget, that’s not what we want at all. So we’ve listened.”

The proposed limitation had been the subject of widespread lobbying in addition to this website page. I am pleased that the Government has listened.

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